After losing nearly two percent of its endowment in Wall Street mogul Bernard Madoff's alleged $50-billion Ponzi scheme, Tufts has been thrust headfirst into a national uproar over red flags, inadequate federal regulations and a crumbling economy.
This chaos, ironically, was born of a desire for stability. And what now looks to be a puzzle piece in an international web of deceit began as just a routine investment, administrators say.
In 2005, the Board of Trustees' Investment Committee approved a $20-million investment in Ascot Partners, a hedge fund that had entrusted nearly all of its $1.8 billion to Madoff by the time his scheme ran out of gas last month.
Administrators say that when it put its money in Ascot Partners, the university was aware of the extent to which the fund was invested in Madoff. And despite widespread allegations from the financial sector that the former Nasdaq chief's numbers were simply too good to be true, they maintain that the university followed appropriate guidelines leading up to the investment.
"Before making this investment, the university followed all of its usual due diligence procedures, including a full legal review and full review of the fund's investment strategy, and an analysis of the risks and strengths of the investment, including audited returns," Director of Public Relations Kim Thurler told the Daily in an e-mail. "In light of this analysis, this investment seemed to be a prudent one."
The university has already written off the total amount of the $20-million investment, and its disappearance will not significantly impact operations, University President Lawrence Bacow told the community in an e-mail.
Meanwhile, Ascot Partners and its manager, J. Ezra Merkin, are already facing lawsuits filed by investors looking to recoup funds. Tufts is currently evaluating available legal avenues, according to Thurler.
"At this time, we can't predict if we will be able to recover any portion of the loss, but we are exploring all our options, including legal action," she said.
For Tufts and other misled investors, any results will likely take time to come to fruition. "This will go on for years," Economics Lecturer of Economics Christopher McHugh said. "Everybody will go after everybody else; I don't think there's any simple legal device."
The casualty list
While Madoff's alleged fraud may have pulled $50 billion out of the economy and left victims scattered across the globe, college endowments have emerged relatively unscathed.
James Hedges IV of LJH Global Investments, a firm that specializes in investing in hedge funds and private equity for wealthy families, told Fortune Magazine that the absence of universities from the casualty list likely stems from their adherence to a more traditional investment playbook.
"[With Madoff], when you get to page two of your 30-page due diligence questionnaire, you've already tripped eight alarms and said, ‘I'm out of here,'" he said.
Aside from Tufts, Yeshiva University, New York University (NYU) and New York Law School have also reported losses. All four institutions shared a common thread: their connection to Merkin.
New York Law School has filed a lawsuit against Merkin, Ascot Partners and a firm that had audited the hedge fund to recover $3 million in the school's investments.
NYU has also turned to the courts, seeking compensation for the $24 million it had invested with Merkin, who also funneled money to Madoff through Gabriel Capital LP and Ariel Fund Ltd. The NYU lawsuit names those two funds rather than Ascot Partners.
Yeshiva originally said it had been hit harder, with school officials initially reporting a loss of $110 million. They now put the number at $14.5 million, noting that the original figure consisted of fictitious returns on their prinicpal.
Other schools have suffered indirectly. The failure of the Picower Foundation, a Palm Beach-based charity that was active in the Boston area, is expected to leave a significant dent in research efforts at Harvard University and the Massachusetts Institute of Technology, for example.
Brandeis University is also expected to feel lingering effects. While the university's endowment did not have any exposure to Madoff, a number of the school's major donors sustained large losses from their personal investments.
Last month, the Boston Globe reported that Carl and Ruth Shapiro, well-known for their donations to Brandeis, the Museum of Fine Arts, Boston and Beth Israel Deaconess Medical Center, lost $145 million in the alleged Ponzi scheme. In the last decade, the Shapiros have contributed around $60 million to Brandeis.
In an e-mail to students, Brandies President Jehuda Reinharz outlined the financial strains the university is facing, noting that it is difficult to conclude how the diminished giving power of donors will impact the school's economic outlook.
"While it was a relief to report that the university never invested money with Bernard Madoff, sadly, some of Brandeis's most staunch and generous supporters suffered major losses," Reinharz said in the e-mail. "It is very hard to calculate the immediate and long-term effects on the university's fundraising results."
Even while most colleges appeared to have stayed away from Madoff, Thurler said that the disgraced financier's investments seemed strategically appealing and safe.
"The investment was to provide a stable, low-volatility return and represented a very small percentage of our endowment," she said.
So far, Tufts economists have hesitated to criticize the trustees' Investment Committee for the $20 million in losses, but they have identified lingering questions.
"I'm somewhat surprised, I must admit, that the whole $20 million was put into one place. I would normally expect that they would diversify to some extent," Professor of Economics George Norman said. "[But] I don't want to second-guess the Investment Committee of the university, because the Investment Committee has done a very good job over the years."
McHugh, who works at the Boston hedge fund New Generation Advisors, placed most of the blame with Ascot Partners. He said that the fund's managers should have pressed Madoff for more details on his investment strategies and insisted on seeing more documentation.
Investors who did grill Madoff generally avoided entrusting their money to him, according to McHugh. "With Madoff … they weren't getting anything, really, except for some cursory statements," he said. "I don't think that Ascot Partners [was] doing their job right."
Still, the university also could have been more cautious, McHugh added. "I do think that perhaps they weren't as suspicious as they should have been," he said.
Beating the market
According to most financial experts, what many saw as the most enticing attraction of investments with Madoff, the regular 10 to 17 percent returns, should have presented itself as the biggest red flag.
While higher returns generally come with added risk, Madoff's strategy appeared to be entirely sound. Instead of questioning the logic of the system, McHugh said, most investors naïvely clung to the belief that Madoff was merely smarter than the market.
"In this business, a lot of people are cocky," he said. "We have a tendency to believe that the market is easy to beat."
According to McHugh, this philosophy flies in the face of the concept of the efficient market. He called Madoff's unfailingly high returns "absurd."
"Anybody who believes in the efficient market would pick that up," he said.
Norman, too, registered surprise that so many investors implicitly trusted Madoff. Still he pointed out that not all did, citing the example of the European bank Société Générale, which internally blacklisted Madoff after noticing a surprising number of warning signs.
"They refused to put money into Madoff's accounts because when they went over and talked to him, they were suspicious," Norman said. "It's surprising that other financial bodies weren't equally suspicious."
The blind faith investors often put in Madoff represents a larger dependence in recent years on hedge funds that aim to significantly outperform the market, McHugh said.
"There are a lot of people out there who want to think that there are these market-beating investors who can pull it off," he said. "There was the perception that they would do better and that they would not have the downside risk, that they were nimble [and] could move around quickly."
Colleges have been particularly drawn to hedge funds in recent years, according McHugh. "For a while, it worked out great," he said. "Everybody loved hedge funds until this year."
A ‘sophisticated' crowd
Even if red flags truly did abound, the ability of Madoff to draw the rich and powerful from around the world into his web of deceit is telling, sources say.
"Let's be frank: Madoff managed to attract a lot of very, very sophisticated people," Norman said. "You're looking at major financial institutions, major banks, all of whom have done their due diligence and decided to invest in Madoff. So it's very difficult to work out where the blame should lie here."
Tufts does indeed join a star-studded crowd of victims, one that includes not only the Picower Foundation and a number of schools, but also Britain's Royal Bank of Scotland; Spain's largest bank, Santander; the Elie Wiesel Foundation for Humanity; a U.S. senator; and a co-founder of the retail store Bed Bath & Beyond.
"We, along with many knowledgeable investors, were deceived by dishonest individuals," Thurler said. "Outright fraud can be difficult to detect through even the most sophisticated systems."
As a result, Tufts administrators and federal officials alike have promised to look into institutional reforms.
"[We] are reviewing our processes and procedures to see if there are any ways to strengthen them or other lessons to be learned," Thurler said.
On the national level, the Securities and Exchange Commission (SEC) has become a popular target for criticism, with detractors saying that the body ignored the warning signs that emerged over the years. In fact, it has come to light that a Massachusetts investor repeatedly warned the SEC over the past nine years about the possibility that Madoff was running a giant Ponzi scheme, but the commission did not take any substantial action. [See sidebar, below, for more information.]
"I think the SEC has got so much egg on its face that it's really got to go and revisit its [policies]," Norman said. "There's a sense that the SEC has been pro-deregulation; perhaps they're going to have to revise their stance on that."
But McHugh argued that additional regulation is not the answer. Instead, he encouraged increased responsibility among individual investors. "The more [we] regulate, the more people say it's not their problem," he said.
Expected impacts on the Hill
The Madoff scandal comes at a difficult time for the university on the financial front. In light of an increasingly dire economic outlook, the administration has projected a 25 percent decrease in the value of the school's endowment this year. In addition, it is planning for an expected $36 million in budget cuts for next year.
In his e-mail to the community, Bacow acknowledged the administration's financial stewardship obligations and pledged to seal any potential loopholes.
"We deeply appreciate the trust and confidence that each donor places in the university," he said. "We also have an obligation to our students and faculty to manage these resources wisely for their benefit."
Director of Advancement Communications and Donor Relations Christine Sanni said that while she expects contributors to share the university's outrage, she does not anticipate a decline in their willingness to give in the wake of the Madoff scandal.
"We don't think this news will affect our efforts to raise funds for our students and faculty," she told the Daily in an e-mail. "Tufts is fortunate in having many alumni and friends who remain as committed to Tufts as ever and a dedicated advancement team that is able to steward those relationships."
University officials have emphasized that they do not foresee any cuts in services stemming from the losses.
"The payout from our endowment for next year is determined by combining the value of all investments, not a single investment, and establishing a percentage payout for all programs," Thurler said.
The Madoff scandal, as well as the expected decline in the value of the university's endowment due to bleak economic conditions, comes in the midst of Beyond Boundaries, a capital campaign aiming to raise $1.2 billion by 2011.
While the campaign's public phase kicked off in late 2006, its quiet stage began in 2002, three years before Tufts made its investment with Ascot Partners. Sanni was unable to say if any of the lost money came from donations made through the campaign.
"Once a gift is made to the university, it's treated as a pooled resource. In other words, the endowment as a whole is invested, not any one gift or fund," she said. "Though there may have been Beyond Boundaries dollars within [the lost funds], it would have been a small portion of what's been raised to date."